Tinker no more

Reforming financial markets will need clarity in rules and coordination within government

Finance Minister P. Chidambaram has promised a fresh focus on financial sector reforms in coming days. Today, the broken bond-currency-derivatives nexus is undermining the fight against inflation. The banking system is in the early stages of an NPA crisis. Ponzi schemes and misselling are causing difficulties for households. Yet, in the field of finance, the government has been operating with the old mindset of the control regime. For instance, extreme distortions in the money market were brought in during the defence of the rupee in 2013, all of which need to be reversed.

The present government has lost credibility by making lofty statements that are not followed through. Bridging the gap between ideas and action requires thinking through the precise drafting of legal instruments, changes in organisation structures in all financial agencies, transformation of teams in financial agencies and the finance ministry, and establishing a mission-oriented work programme. The old status quo of financial policy where India ran a licence-permit raj in finance with hundreds of detailed controls on all products and processes has been thoroughly discredited, and there is a need to start over.

Reforming financial markets is important today, not only for domestic reasons but also for attracting foreign capital, which is needed for bridging the current account deficit. In the present system, rules on FDI, FII or indeed, the recently proposed foreign portfolio investor (FPI) regimes, are not clear. Even where there has been a liberalisation, there has been no clarity on the rules, the tax status or the objective. Whether it is the tax demand on Vodafone or the registration for FPI, the functioning of the government indicates lack of coordination and the lack of a common vision. One of the most important missing elements is the rule of law. Reform has little use if arbitrary rules framed by different arms of different regulators and departments of government prevent it from being effective. The way forward has been outlined by the FSLRC, which has proposed moving away from the licence permit raj to regulated financial markets, the kind of liberalisation that was implemented for industry in 1991 but has still to touch Indian finance. Hopefully, the reform Chidambaram has in mind is such fundamental reform, and not more tinkering with the system.

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